The defence secretary has resigned his position with "great sadness", folding under the pressure of daily revelations about the man he gave access to the heart of government and British defence strategy.

Liam Fox became the first of Cameron's Conservative cabinet ministers to leave in the 17-month life of the coalition and now triggers the prime minister's first reshuffle, an operation he had wanted to avoid until half way through the parliament.

Though the chief secretary to the Treasury, David Laws, resigned only 17 days into the formation of the coalition, that was by necessity only a reshuffle of Lib Dem cabinet ministers since the coalition agreement stipulates there must be five in the cabinet. It is expected Cameron will perform a limited reshuffle, merely replacing Fox without going reorganising his entire government lineup.

Rumours that the transport secretary, Philip Hammond, would be Fox's replacement were dubbed speculation by his office within half an hour of Fox's resignation.

Other names rumoured to be in the frame include the northern Ireland secretary, Owen Paterson, and the international development secretary, Andrew Mitchell. It was even suggested that the former foreign secretary Malcolm Rifkind currently on the backbenches, could be recalled to the cabinet. That would avoid the need to replace someone in another cabinet post.

Downing Street insisted Fox had not been pushed into resigning over the activities of his friend Adam Werritty but it was a decision taken by him with "dignity".

However, senior figures inside Downing Street were worried that the former defence secretary's position had become untenable when fresh stories emerged in the first editions of newspapers on Thursday night. Cameron's team were alarmed that journalists had began to establish where the funding for Adam Werritty's lobbying activities had come from.

The Times unearthed a corporate intelligence company with a close interest in Sri Lanka, a property investor who lobbies for Israel and a venture capitalist keen on strong ties to fund the £147,000 bill he notched up on travel and hotels, sometimes including first class travel and five-star hotels.

In his resignation to the prime minister, Fox said: "I mistakenly allowed the distinction between my personal interest and my government activities to become blurred. The consequences of this have become clearer in recent days. I am very sorry for this.

"I have also repeatedly said that the national interest must always come before personal interest. I now have to hold myself to my own standard. I have therefore decided, with great sadness, to resign from my post as secretary of state for defence – a position which I have been immensely proud and honoured to have held."

Fox crumpled under the weight of this week's revelations and the prospect of another weekend of speculation. He could not hold out until the inquiry into his behaviour wound up officially – expected to be at some point next week. The prime minister had always held out the right to exercise his own judgment and keep Fox in his post even if the report were critical, but the defence secretary decided to bypass the process and limit the personal and political damage.

It is understood that Werritty's appearance before Sir Gus O'Donnell – the man performing the inquiry to establish the propriety of his work – did not impress the cabinet secretary.

In his response to Fox's resignation letter, the prime minster said Fox had overseen key changes in the Ministry of Defence "which will ensure that they are fully equipped to meet the challenges of the modern era".

He added: "You can be proud of the difference you have made in your time in office, and in helping our party to return to government.

"I appreciate your commitment to the work of this government, particularly highlighting the need to tackle the deficit, and the relationship between Britain's economic strength and our national security."

Fox was a well-liked secretary of state for defence overseeing a successful campaign in Libya, though he did disagree with the prime minster over the way it was carried out.

In his resignation statement, he said: "I am proud also to have played a part in helping to liberate the people of Libya, and I regret that I will not see through to its conclusion Britain's role in Afghanistan, where so much progress has been made. Their bravery, dedication and professionalism are second to none."

Fox will now join the backbenches where he enjoys some popularity but it is not expected he will act as a lightning rod for discontent.

In his resignation statement, Fox said: "I appreciate all the support you have given me – and will continue to support the vital work of this government, above all in controlling the enormous budget deficit we inherited, which is a threat not just to this country's economic prosperity but also to its national security."